I was talking to a friend the other day and after a while our conversation turned to investing. We talked about how smart it was to invest your money instead of spending it or stashing it away in a savings account. And eventually I asked my friend how he invested his money. And his answer, of course, was his 401K.

He talked about his company match and we talked about how getting a company match is like free money. Then we discussed the great tax benefits from investing in a 401K. And then I asked him what he had his 401K invested in? And all I got was a stare with a crumpled forehead.

I repeated my question and tried to explain myself further, asking him what investments were in his 401K (index funds, mutual funds, etc.). By this time I was beginning to understand that he had no clue. But he definitely didn’t want to admit this, so he stammered something about how it had been so long since he looked that he couldn’t remember.

But the problem wasn’t that he couldn’t remember, the problem was that he didn’t know that a 401K is NOT an investment.

If you are a little confused by that statement, then you’ve come to the right place and you’re not alone. In fact, before I started exploring the world of finance, I was right where you are. They don’t teach this stuff in school so we are left to fend for ourselves. And it seems scary or boring or complicated so we never learn. But your money is an incredibly important part of your life and having enough money is one of the keys to a happy life. So let’s dive in to the 401K today and see if we can’t make it easier to understand and maybe even a little fun.

The Little Red Car

Your 401K is not an investment, it’s an investment vehicle. Just think of it as a little red car that you drive around and pick up investments in. As you drive around you see a mutual fund or an index fund and you put it in your car. And those funds are invested in stocks or bonds, which really just means that you are invested in lots of companies (stocks) or loans (bonds). So when someone asks what you are invested in, the answer is the mutual funds or index funds that you have in your 401K car, not the car itself.

So why do we have the 401K car to begin with? Because it protects our investments from taxes. Since our investments are in the 401K car, the government doesn’t tax them. If our investments are not in the 401K car and are cruising the streets in a traditional brokerage account convertible, the tax man is able to pull them over and forces you to pay taxes on them.

Who Should Be in the Car?

Now that you understand that your 401K is really just the car that drives the investments around, let’s talk about who you should be picking up in that car and how to do it.

I’m a big fan of investing in index funds because they cover all the bases for me. They make it so my investments are diverse (invested in hundreds of companies), simple, and inexpensive. Plus, Warren Buffett recommends them to average investors and wants 90% of his wealth invested in them for his wife when he dies, and that’s good enough for me. (That and the fact that statistics back them up and I like cold, hard data.)

But you shouldn’t just take my word for it. Go out there and do your own research. Find out more about investments until you are comfortable making your own decisions. It won’t take as long as you think. (And you’ve already started just by reading this article.)

Picking Up Your New Friends

So now is the hard part, you have to actually go into your 401K, look at it, and change what you are invested in. Most of us never really did this. When we signed up for the 401K, we went on their website and selected some type of portfolio (Balanced, Growth, Aggressive Growth, etc.) and that was it. The 401K people did the rest. We didn’t even understand that we had the option to select what our money was really invested in.

So now when you go into your 401K you’ll have to actually look at the funds that your 401K allows you to invest in. When I did this I was looking for a total stock index fund or an S&P 500 index fund. I found an S&P 500 index fund, buried in a bunch of other much more expensive funds, and was thrilled.

Now all you need to do is tell the 401K website that you want to manually select your own funds and do two things:

  1. Transfer all of your current investments into the investments of your choice (I picked the S&P index fund for everything).
  2. Allocate your future contributions to go into the investments of your choice (again, I went with the index fund).

Warning: You are going to need to be persistent to do this because when I did this for my 401K and my husband’s 401K (through different brokerage companies) both of the websites made it difficult to even find out where to switch to investing manually. But just treat it like a treasure hunt and keep going until you find the prize.

Your 401K can be a great tool used to find financial success, peace of mind, and, ultimately, happiness. Now you simply have to learn how to use it. But that’s okay because Adventurers are always up for a challenge.

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